What the last 3 months taught us about diversification

It seems that every time you open any sort of business news, the story is about Artificial Intelligence (AI) – unless it’s the President of the United States declaring yet another victory over Iran this year. As such, any thoughts and narrative about markets is always driven by AI. This has led many commentators and participants to believe that all financial markets are sat on a one-legged stool, and that leg is AI. Perhaps even extending as far as to say there is too much AI driven heat in all markets, or alternatively it has led others to believe that US tech is the only game in town and everything else follows.

But we have seen something interesting over the last three months. Admittedly three months is a short period of time, but there has been quite a meaningful sell off (followed by slight recovery) of US tech stocks. The Nasdaq went into correction territory in June and July, dropping by more than 10% in value. But this really wasn’t felt, why was that?

Apologies to those who don’t like charts, but I think this one tells the story really well. The key lines in question are the light pink (Nasdaq, representing US tech), the dark purple (European stocks index) and red (UK stocks index).

What we see here, is that while US tech was (almost) silently having a -10% correction, European and UK equities rallied nicely. This flies in the face of the theory that everything is linked to AI or US tech. In fact the constituents of these markets are very different. This shows there are many other factors driving markets in the world. Banking stocks did very well in both European and UK markets, somewhat driven by higher interest rates expectations. Defence stocks continued to push up the UK markets as, sadly, various wars continue to rumble around the world. On top of this, Aerospace and energy transition also helped to drive these markets higher. 

This diversification becomes even more pronounced when you look at the performance of semi-conductor stocks over the same period, which have essentially driven the majority of AI related market growth:

This sector’s stocks fell over 27% in just over a month (from top to bottom), again without making much noise. You could argue that this was a market that was running very hot, but a decent amount of heat came out of this market and the broader market reaction was quite muted.

So, again, three months is a short period of time, but markets definitely showed that there is more than one leg to the stool that they are sitting on – with different parts moving at different times. This diversification is excellent news to portfolio managers and investors alike. As the semiconductor sector (the driver of AI returns in the last one-two years) went into a bear market (>20% drop), our equity allocation drifted up by 3% over the same period. This isn’t to say that markets would be immune to a more meaningful and consistent sell off in semi-conductors or other sections of the AI market place, but this would require a much bigger event to occur. In the meantime we remain happy with our equity allocation and continue to focus on making sure we maintain a well-diversified exposure.

If you have any questions about any of this, please don’t hesitate to reach out to our team, who would be more than happy to discuss your own portfolio with you.

Please remember that when investing, your capital is at risk. The value of your portfolio with Moneyfarm can go down as well as up and you may get back less than you invest. Past performance is not a reliable indicator of future performance. The views expressed here should not be taken as a recommendation, advice or forecast. If you are unsure investing is the right choice for you, please seek financial advice.